Like It or Not, a Secured Credit Card Might Be the Key to Rebuilding Your Credit

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If you’re trying to improve damaged credit but getting nowhere, you may find yourself with this common conundrum: You’re ready to fix your past mistakes, but no one will give you a new account and a chance to prove your creditworthiness.

Unfortunately, this catch 22 is a tough position to be in. After all, how can you build credit if you can’t get anyone to give you the opportunity to use credit in the first place?

Despite all the horror stores, a secured credit card could be your ticket out of bad credit purgatory. Yes, they often come with higher-than-average fees and lower credit limits, but these cards might be your only – and best – option.

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How Does a Secured Credit Card Work?

Due to their less than stellar terms and conditions, secured credit cards may not look that attractive to the naked eye. But if you dig a little deeper, you’ll find a financial tool that can actually improve your credit when you’re unable to qualify for anything else.

“If you have no credit history or a credit score below 600, sometimes your only credit option is the secured card,” says financial planner Shannon McLay of the Martinis & Your Money podcast.

But, how does a secured credit card work? As Bank of America explains, “A secured credit card uses money you place in a security deposit account as collateral.” Further, your credit line is based on your income, your ability to pay, and the amount of your cash deposit. Most of the time, it’s not very much – usually in the $300 to $500 range.

Here’s a good example of how secured credit cards work: Let’s say you apply for a secured credit card and put down the required $500 deposit. Based on your income and ability to repay, your credit line should also be $500 – the amount of your deposit. This is where the term “secured” comes into play: By putting down the cash deposit, you’ve secured your very own credit line with collateral.

Why Would Someone Get a Secured Credit Card?

Since secured credit cards require you to put down a deposit equal or similar to your credit limit, it’s easy to wonder why anyone would bother. Doesn’t the low limit and deposit cancel out any potential benefit?

While it’s true that secured credit cards don’t work exactly like regular cards, they do come with benefits that can help credit-challenged consumers. Here are the main benefits – and the main reason people use these offers time and again:

Secured credit cards can help you improve your credit score.

Just like unsecured credit cards, most secured cards send your payment history to the three major credit reporting agencies – Experian, Equifax, and TransUnion. That means paying your bill on time each month and following your card’s terms and conditions will be reported to the very companies that determine your credit score.

As Forbes contributor Curtis Arnold says, “This makes a secured credit card an extremely valuable tool if, and this can’t be emphasized strongly enough, you are timely and consistent in paying your bill.”

Secured credit cards can help you re-learn healthy money habits.

Whether your credit spiraled out of control after a job loss or during the recession, or you just haven’t built a credit history yet, a secured credit card can help you learn (or re-learn) all the basics.

Getting used to the cycle of making a purchase with your card, receiving the bill in the mail, and paying it in full by the due date — until the process is automatic — has huge benefits that can compound over time.

Secured credit cards can pave the way to unsecured cards.

Although secured credit cards typically come with higher fees and unattractive terms, your use of them may only be temporary. If you use your secured card responsibly for a period of 12 months or more, you may be able to upgrade it to an unsecured card with fewer fees and better terms, says McLay.

“When you apply for a secured card, you need to make sure you manage it responsibly, keep your utilization below 20%, and pay your bills on time, and then petition your secured card company for an unsecured card,” she says. “If they won’t graduate you, despite your good behavior, then shop for unsecured cards and, once you get from another company, close your secured card.”

Secured Credit Cards: What to Watch Out For

When it comes to choosing a secured credit card, there are plenty of landmines to avoid.

First and foremost, some of the least attractive options come with fees that are considerably higher than competing cards. Even within the secured card niche, factors like interest rates, maintenance and account fees, and activation charges can vary wildly. It pays to shop around.

Further, you’ll want to make sure your secured credit card does, in fact, report to the three credit reporting agencies. Because if it doesn’t, what’s the point? If you can’t find a definitive answer in their marketing materials, you should definitely give the company you’re considering a call and ask before you sign up.

As a final step, you’ll want to make sure you understand your cards terms and conditions – even if that means enduring several pages of fine print. It’s important to know how your card will work and how long your grace period is to avoid paying interest on your purchases.

Final Thoughts

Is a secured card the best way to improve your credit? According to McLay and other experts, it’s definitely something to consider – especially if you can’t get credit anywhere else.

You might have to pay a few more fees, but at least you’ll be on your way to improving your credit score in the long run. And once you do, you can get rid of that secured card and replace it with a traditional, unsecured credit card with better terms and a whole lot more perks.

Have you ever used a secured credit card to build credit? Why or why not?

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